Annual Financial Report

Montanaro UK Smaller Companies Investment Trust PLC Annual Report and Accounts 2009 The full Annual Report and Accounts 2009 can be found on the Company's website www.montanarouksmaller.co.uk The Montanaro UK Smaller Companies Investment Trust PLC ("MUSCIT") was launched in March 1995 and is listed on the London Stock Exchange. Investment Objective MUSCIT's investment objective is capital appreciation (rather than income) achieved by investing in small quoted companies listed on the London Stock Exchange or traded on the Alternative Investment Market ("AIM") and to achieve relative outperformance of its benchmark, the FTSE SmallCap (excluding investment companies) Index ("SmallCap"). No unquoted investments are permitted. Investment Policy The Company seeks to achieve its investment objective by investing in a portfolio of quoted UK Smaller Companies. At the time of initial investment, a potential investee company must be profitable and smaller than the largest constituent of the HGSC Index, which represents the smallest 10% of the UK Stock Market by value. At the start of 2009, this was any company below Â£911 million in size. The Manager focuses on the smaller end of this Index. In order to manage risk the Manager will normally limit any one holding to a maximum of 5% of the Company's investments. The portfolio weightings of every stock are closely monitored to ensure they reflect the underlying liquidity of the particular company. The Company's AIM exposure is also closely monitored by the Board and is limited to 30% of total investments with Board approval required for exposure to be above 25%. The Manager is focused on identifying high quality niche companies operating in growth markets. This typically leads the Manager to invest in companies that enjoy high barriers to entry, a sustainable competitive advantage and strong management teams. The portfolio is therefore constructed on a "bottom up" basis and there are no sectoral constraints placed on the Manager. The Board, in consultation with the Manager, is responsible for determining the gearing strategy of the Company. Gearing is used to enhance returns when the timing is considered appropriate. The Company currently has a credit facility of Â£15 million through ING Bank. The Board has agreed to limit borrowings to 25% of shareholders' funds. Highlights 2009 Results - Net Asset Value ("NAV") -35.7% (Â£66m) - Gross assets -40.0% (Â£71m)* - Share price -37.6% (market capitalisation Â£51m) - FTSE SmallCap (excluding investment companies) Index -46.9% Year to 31 Year to March 2009 31 March 2009 Revenue return on 2,465 1,358 ordinary activities (Â£000) Movement in capital (37,721) (23,586) reserve (Â£000) Revenue return per 7.36p 3.82p ordinary share Dividend per ordinary 6.85p 3.65p share Total return per (105.18)p (62.48)p ordinary share As at 31 Year to March 2009 31 March 2009 Ordinary share price 153.00p 245.00p NAV per ordinary share 195.94p 304.52p *Over the year the Company bought shares for cancellation, which accounted for a reduction of Â£308,000 in gross assets. Chairman's Statement Highlights 2009 - In the year to 31 March 2009, the NAV of MUSCIT decreased by 36% to 196p in comparison with a 47% loss by the SmallCap. - Since launch, the NAV of MUSCIT has increased by 96% in comparison with a loss of 15% by the Small Cap outperforming by 111%. - The Board is responsible for the share buy back programme. During the year 145,500 shares were bought for cancellation and 1,828,000 shares were cancelled from Treasury. There are currently no shares held in Treasury. Background I am pleased to present the fourteenth annual report of the Montanaro UK Smaller Companies Investment Trust (MUSCIT), which was launched in March 1995. In 1996, the initial investment of Â£25 million was increased in size through a Â£30 million "C" share issue. Net assets now stand at Â£66 million. MUSCIT is an attractive vehicle for shareholders to invest in a portfolio of quoted UK Smaller Companies, which are less well researched and more illiquid than larger, blue chip companies. Performance In the year to 31 March 2009, the NAV of MUSCIT decreased by 35.7% to 195.9p in comparison with a 46.9% fall by the FTSE SmallCap (excluding investment companies) Index ("SmallCap"). Since launch, the NAV of MUSCIT has increased by 95.9% in comparison with a loss of 14.8% by the SmallCap, outperforming by 110.7%. Discount The discount of MUSCIT's share price to NAV stood at 21.9% on 31 March 2009 in comparison with a weighted sector average of 16%. As at 5 June the discount of MUSCIT's share price to NAV stood at 13.7% (Source: Close Wins Investment Trusts). Share Buy Backs The Board is responsible for the implementation of the share buy back programme which is undertaken at arms length from the Manager. During the year 145,500 shares were bought back and cancelled. A breakdown of shares bought back for cancellation is disclosed in Note 15. Holding Shares in Treasury Since December 2003, Investment Trusts have had the right to buy back shares and hold them in Treasury for re-issue at a later date. This has the benefit of improving liquidity as well as retaining the opportunity to enhance the net asset value. The Board has actively and carefully considered the use of Treasury Shares and has been among the industry's pioneers. Our policy is to ensure that shareholders receive a tangible benefit above and beyond an enhanced ability to manage the liquidity of the shares of MUSCIT. Shares held in Treasury will only be re-issued at a lower discount than when they were originally purchased and to produce a positive absolute return. Shares not re-issued will be cancelled within one year from purchase. In line with this policy, the Company cancelled 1,828,000 shares, representing 5.18% of the issued capital, that were bought into Treasury in December 2007. This cancellation had no effect on gross assets. However, the buybacks noted above accounted for a reduction in gross assets of Â£308,000. As at 31 March 2009 there were no shares held in Treasury. Gearing The Board reviews the level of gearing considered appropriate for the Company in discussion with the Manager. One of the benefits of investment trusts is the ability to hold prudent levels of gearing which can enhance investment returns. During the course of year, the Board decided to reduce the size of the facility with ING Bank N.V. from Â£25m to Â£15m, a level more appropriate for the Fund following the recent market declines. At 31 March 2009, Â£5m was drawn down at an interest rate of 2.69%. During the year, net gearing ranged from 3.8% to a net cash position of 3.7%. At 31 March 2009 the Company had a net cash position of 1.8%. Value Added Tax (VAT) In 2004 the Association of Investment Companies (AIC) and J.P.Morgan Claverhouse (Claverhouse) brought a case against Her Majesties Revenue and Customs (HMRC) to challenge the VAT charge on management fees paid by investment companies. Following the successful claim by AIC/Claverhouse, investors will be aware that the Board of MUSCIT lodged its appeal to recover both the VAT paid on the investment manager's fees and the interest due. We are pleased to report that this matter has been brought to a timely resolution and that during the course of the financial year all due VAT and associated interest payments were received. A total of Â£1.3m was split between the revenue and capital accounts, which had the effect of adding 3.9p to the NAV. The Board has decided to pay out the revenue element in full, a payment that the Board considers to be of a non-recurring nature. Dividend MUSCIT's primary focus is on capital growth rather than income. It is the Board's stated policy to endeavour to pay out at least 90% of its income each year. Accordingly, the Board proposes a final dividend of 6.85p per ordinary share payable on 14 August 2009 to shareholders on the register at the close of business on 26 June 2009. As a result of the refund of VAT received on past managerial fees this dividend includes a non-recurring element of 1.99p per ordinary share amounting to Â£666,000. Corporate Governance The Directors have thoroughly reviewed the recommendations of the 2008 Combined Code on Corporate Governance (the "Code") and have implemented procedures where appropriate, such as an annual evaluation of the Board's performance. Consequently, MUSCIT has complied with the Code throughout the year except where compliance would be inappropriate given the size and nature of MUSCIT. Compliance with the Code is included in the Directors' Report. Directorate Change Following nine years of outstanding service to the Trust, in particular his Chairmanship of the Audit Committee, Antony Hardy has announced his decision to retire and will stand down at this year's AGM. On behalf of the Board, I would like to thank Antony for his hard work and valuable contribution to the Company and extend our very best wishes to him for the future. It was announced in March that Roger Cuming, who is Head of Investments at Reliance Mutual, would join the Board on 5 June 2009. I would like to warmly welcome Roger who will make a worthy addition to the Board. Chairman's Comment The excesses of the past decade unravelled in a matter of months as the global economy entered unchartered waters last year. In America, Lehman Brothers was declared bankrupt, AIG was rescued by the U.S. Government and Citibank shares fell to $1. In the UK, VAT was cut by 2.5% and the banks lined up for Government support as the tax payer became the majority shareholder in both Lloyds and the Royal Bank of Scotland. In Europe, Iceland, Hungary, Latvia and Ukraine all sought aid from the IMF as Eastern Europe threatened to implode. Governments were forced to act decisively to restore some semblance of confidence. The Monetary Policy Committee slashed interest rates from 5.25% to an all time low of 0.5%. Along with this monetarist activity, fiscal packages were also introduced to stimulate the economy. In the UK, a Â£20 billion package was announced, while in Germany the figure was â‚¬31 billion. These efforts were cast into the shade by February's announcement that the Americans would commit $787 billion in an effort to revive their economic fortunes. Hopes that the worst of the downturn could be limited to the financial sector evaporated over the course of the year. The manufacturing sector in the UK suffered severely. Despite the Government's policy of "competitive devaluation" industrial production fell 11% in the year to January 2009. Inevitably, global markets took fright and it proved to be a dismal year for UK SmallCap, as the Company's benchmark fell by 47%. To put the last twelve months into a broader context one needs to look at the Hoare Govett Smaller Companies Index ("HGSC"), which represents the bottom 10% of the market by value. 2008 was the second worst year since records began in 1955, only eclipsed by 1974. While there are many challenges ahead we think it is important to step back and remember some important lessons from history. Montanaro's internal studies suggest that, although UK SmallCap faces a challenging period as the economy enters recession, it outperforms during the recovery. This movement is amplified by the lack of liquidity that exacerbates the underperformance against large stocks on the way down, but works in its favour in bull markets as investors raise their risk profile and buy small companies. Looking back through the 55 years of data for the HGSC, there have been seven discernible bull markets. Excluding the possibly unique bull market which ran from 1974 to 1987, the average return has been 151% over a life of 54 months. This equates to an annual return of 23%. Small Companies have not only delivered substantial absolute returns, but they have also achieved impressive outperformance against the FTSE AllShare ("LargeCap") over these periods. The average annual relative outperformance against their larger peers was 7%. These statistics should give considerable cause for optimism. While past performance can be no guide to future returns, there is a clear and consistent message: UK SmallCap delivers sizeable returns in bull markets that outstrip the returns of other equity classes. Of course we cannot forecast when the market will finally turn. However, with valuations at twenty year lows, the benchmark trading below book value and signs that the macro-economic environment may be stabilising, long-term investors should consider increasing their investment in UK SmallCap. David Gamble Chairman 10 June 2009 Manager's Report Highlights 2009 - It has been a year in which avoiding the major, high profile disasters has provided a significant boost to relative performance. - Although M&A activity evaporated in the second half of the financial year, the portfolio benefitted from three takeovers in its first six months. - 71% of our holdings are in companies with a market capitalisation of under Â£300 million. Portfolio Management The past year has underlined the merits of disciplined, fundamental investing. While the portfolio has always focused on the highest quality companies, in an environment where order-book visibility is deteriorating rapidly and access to credit is uncertain, it has been crucial to think independently and not rely solely on management guidance or broker forecasts. Our team of analysts has placed great emphasis on running sensitivity checks on portfolio holdings and challenging the market's earnings assumptions. We have focused on investments where we have the greatest conviction, leading us to reduce the number of holdings from 66 to 61. Where we have seen a real threat to earnings numbers, or where we have sensed heightening concern over balance sheet structure we have acted swiftly and decisively to sell positions. It has been a year in which avoiding the major, high profile disasters has provided a significant boost to relative performance. In a market dominated by the banks' efforts to recapitalise their balance sheets, many of the most significant market casualties have been those companies which have over-extended themselves. This market has entirely reappraised balance sheets; the efficient (i.e. geared) balance sheets that were the order of the day just two years ago are now considered stretched and threaten the very existence of some companies. The search for "efficient capital structures" has left a poisonous legacy that has been thoroughly exposed by both the trading downturn and an intolerant banking system. We have always focused on the highest quality companies. A crucial element of this assessment has been a strong emphasis on cash generation and balance sheet strength. We were aware of this trend towards secure balance sheets and recognised that the market was not going to give companies the benefit of the doubt. We sold down holdings that we considered vulnerable. The decision to sell holdings like DTZ and White Young Green that had both over-extended themselves during a sustained period of acquisitive growth proved timely. Despite the challenging environment, there have been some strong drivers to the overall performance of the portfolio. The most significant contributor to performance was Dechra Pharmaceuticals which rose 14% over the year. The distributor of veterinary supplies extended its position as an emerging manufacturer of veterinary pharmaceutical products as it achieved FDA approval for products in the U.S. market. Mothercare, the specialist children's retailer, also held up well in the adverse market conditions. Its shares fell by just 5%, illustrating that strong consumer propositions can deliver impressive performance across the economic cycles. We continue to like the company and believe it will emerge from the current downturn with a strengthened competitive advantage following the plight of competitors such as Woolworths and Adams. Although M&A activity evaporated in the second half of the financial year, the portfolio benefited from three takeovers in its first six months. The most significant was Detica, an IT specialist serving the security and financial services markets. The company, which had been held for over four years, was bought by British Aerospace at a 55% premium. The other two businesses acquired were IBS OpenSystems, a software business acquired by Capita and Gibbs and Dandy, a builder's merchant, acquired by St. Gobain. Annual Returns Over the course of the financial year, the FTSE SmallCap Index fell almost 47%. At times the markets were driven by fear. Remarkably, at the height of the financial drama over nine weeks from mid September 2008 to mid November 2008, our benchmark fell 37%. Investors clearly panicked. In reporting such significant falls in asset value, it feels a very hollow achievement to report that the Company has outperformed its benchmark by 11%. This outperformance demonstrates the merits of a disciplined investment process that has now led to outperformance for five consecutive years, in which time returns 40% ahead of the benchmark have been delivered. This strong relative performance has had an unintended consequence. The portfolio now has a higher weighting of FTSE 250 holdings than at any time in the past. At 31 March 2009, 41% of the portfolio was made up of FTSE 250 stocks, which compares to 28% at 31 March 2008 and just 15% in March 2007. There have been significant changes to the make up of the FTSE SmallCap Index. Over the last two years, our benchmark has become increasingly populated by many former FTSE 250 and even FTSE 100 companies which in many cases have been blighted by difficult trading conditions. Many companies that have replaced them in the mid-cap index have been the defensive names which have delivered consistent performance. From our portfolio, Dechra Pharmaceuticals, James Fisher and eaga have all been promoted in the last year. We have not felt it necessary to reduce this larger weighting in FTSE 250 Index stocks and believe that, in the present environment, the greater liquidity that these holdings provide has been helpful. It is important to note that this has not come about through the purchase of new holdings in the FTSE 250 but has been achieved organically through good performance. The companies that have been promoted are therefore companies we have known for many years. The knowledge, insight and understanding we have built over this time will, we believe, prove very valuable to sound portfolio performance over the medium-term. As the table below illustrates, 71% of our holdings are in companies with a market capitalisation of under Â£300 million. We remain committed to investing in "smaller" companies that are less well researched and where we feel we can add most value. We believe it is this corner of the market which will be the primary driver of the future growth of the Company and is consequently the source of our new ideas. Market Capitalisation of Holdings by value (31/03/2009) Â£0-Â£50m 12% Â£50 - Â£100m 17% Â£100 - Â£200m 29% Â£200 - Â£300m 13% Â£300 - Â£600m 21% Â£600m+ 8% As a part of our commitment to investing in smaller companies, we continue to take a measured approach towards the Alternative Investment Market (AIM). While home to many very small, loss making and foreign domiciled businesses, a select band of impressive companies can also be found at an early stage in their development. The twelve AIM companies within this portfolio have proved to be beneficial to overall portfolio performance. We are encouraged that two of the holdings (Booker and Hargreaves Services) have stated their intention to move up to the Full List. For dynamic companies delivering sustainable growth, AIM should be a stepping stone towards broader recognition and a wider audience which can only help drive investment returns over the longer-term. Market Outlook This recession is proving to be more severe and protracted than commentators had initially forecast. In this April's Budget the Government revised their forecast economic contraction for 2009 from -2.25% to -3.5%. This still appears optimistic in comparison to the bleak estimate of a 5% decline by PricewaterhouseCoopers. If this latter most pessimistic forecast is proved correct, economic conditions will be the worst year since 1931. Those readers who know their history will be aware that this led to a significant electoral defeat for the Labour Government. With this downturn having a grave impact on public finances, there would appear to be every chance of history repeating itself. Macro-economic news is likely to continue to be bleak throughout 2009. Unemployment figures are expected to rise inexorably towards the 3 million level. The consumer is understandably chastened. Recognising the unsustainable levels of debts that he has carried before he is retrenching. Inevitably, and not before time, the savings rate has improved. The recent pick up from -1% to almost 5% will do little to help the beleaguered high street and there is every reason to expect this rate will move higher still; it reached over 10% in the 1991/2 recession. There can be no doubt that markets have proved themselves to be hugely efficient in calling this downturn. The FTSE SmallCap Index peaked in June 2007, eighteen months before western economies officially entered recession. At the end of March 2009 our benchmark had registered a peak to trough decline of 65%. This highlights a crucial point - markets are forward looking. We would therefore expect markets to bottom in the middle of the recession, illustrating the over used but often apt message, that it is always darkest before the dawn. Although markets tend to seek to discount six to nine months forward, it remains challenging to identify when we can expect that dawn to break. It may have done so already. What we do believe is that there is value in the market. Earnings forecasts for 2009 remained stubbornly high for too long. Management teams were generally late to recognise the severity and speed of the downturn and as a consequence proved to be overly optimistic. The world changed in autumn last year and we have subsequently seen recognition of the challenges ahead. UK SmallCap earnings forecasts for 2009 have been cut by approximately 20%. While visibility remains limited and there remains downside pressure, the numbers in the market place appear more realistic. It is therefore interesting to note that UK SmallCap is now trading at a discount to large stocks for the first time in five years. We consider this a necessary precursor to a reappraisal of the SmallCap investment case by many who have stood on the sidelines for the last two years. At the end of March 2009, UK SmallCap was trading at 60% of book value making it far cheaper to buy companies on the stock market than it is to build them. As the credit markets re-open we would expect a pick up in M&A activity, possibly led by overseas buyers. The collapse in sterling makes British businesses considerably cheaper to buy for many American and European companies compared to just over a year ago. This would not only help markets to establish a floor, but it is likely that it would prove beneficial to this portfolio which has seen more than its fair share of takeovers in the past, with a total of eighteen over the last three years. There are some encouraging early signs. It appears that the period of smaller companies underperforming larger companies might be drawing to a close. Since the start of 2009, we have seen the FTSE SmallCap Index outperform the FTSE AllShare Index by over 20%. This not only provides a potentially early indicator that the tide may finally be turning for UK SmallCap, but reminds investors of the benefits of a diversified portfolio that includes SmallCap. Having outperformed for 12 years out of 14, we believe investors are best rewarded over the longer term by investing with an experienced manager whose investment process has delivered over several market cycles. At Montanaro, we have one of the largest dedicated SmallCap research teams and believe that this resource is the key to generating these consistent returns through bottom up stock picking. I would like to record my thanks to our Chairman, Board of Directors and shareholders for their help and support during this challenging year. Dan Harlow Montanaro Investment Managers Limited 10 June 2009 Description of Thirty Largest Holdings as at 31 March 2009 Dechra Pharmaceuticals PLC Manufacturer and distributor of veterinary products and pharmaceuticals. Fisher (James) & Sons PLC Provider of specialist marine support services and operator of tankships around UK coastal waters. Dignity PLC The UK's largest provider of funeral related services. BPP Holdings PLC The leading provider of training services to the legal, accountancy and financial markets. Domino's Pizza UK & IRL PLC The UK and Ireland's leading pizza delivery company. Hargreaves Services PLC A leading provider of transport and support services to the energy and waste sectors. Latchways PLC World leader in the design, manufacture and sale of safety systems for individuals working at height. Mothercare PLC The leading global retailer of parenting and children's products. Ricardo PLC The leading UK independent automotive consultancy. Chloride Group PLC An international provider of secure power solutions for the business continuity of customers worldwide. Genus PLC A world leader in the application of genetics to animal breeding. NCC Group PLC A provider of escrow solutions, assurance testing and consultancy. Albemarle and Bond Holdings PLC The UK's market leading pawnbroking business. London Capital Group PLC A provider of spread-betting products on the financial markets to retail clients. James Halstead PLC A manufacturer of commercial resilient floor-coverings to the worldwide market. Brewin Dolphin PLC The UK's largest independent private client Investment Manager. eaga PLC The UK's leading provider of residential energy efficiency solutions. Barr (AG) PLC The soft drink group, best known for producing Irn Bru. Domino Printing Sciences PLC An international group providing total coding and printing solutions to a wide portfolio of market sectors. Wilmington Group PLC Leading provider of information and training to business and professional markets, with particular strength in the legal and regulatory sectors. Care UK PLC An independent provider of health and social care service solutions. Croda International PLC A manufacturer of speciality chemicals for the consumer care and industrial markets. BSS Group PLC A specialist in the marketing and distribution of heating, plumbing, and mechanical services equipment. Consort Medical PLC A leader in medical devices for inhaled drug delivery and anaesthesia. M.P. Evans Group PLC A producer of Indonesian palm oil and Australian beef cattle. Mears Group PLC A leading social housing repairs and maintenance provider with a growing presence in the domiciliary care market. Carclo PLC A supplier of fine tolerance, injection moulded plastic components which are used in medical, automotive, telecom and electronics products. Phoenix IT Group PLC A provider of a range of IT support services, including Business Continuity, hosting, service desks, and network and systems management. Chemring Group PLC A specialist manufacturer of decoy countermeasures and energetic materials for the global defence, security and safety markets. Booker Group PLC The leading wholesaler for caterers, retailers and businesses. Fifty Largest Holdings as at 31 March 2009 Value % of Market Cap Holding Sector Â£0 portfolio Â£m Dechra Pharmaceuticals PLC Pharmaceuticals and Biotechnology 2,593 4.0 274 Fisher (James) & Sons PLC Industrial Transportation 2,187 3.4 203 Dignity PLC General Retailers 2,145 3.3 342 BPP Holdings PLC Support Services 1,963 3.1 176 Domino's Pizza UK & IRL PLC Travel and Leisure 1,766 2.8 365 Hargreaves Services PLC Support Services 1,757 2.7 112 Latchways PLC Support Services 1,683 2.6 53 Mothercare PLC General Retailers 1,632 2.5 340 Ricardo PLC Support Services 1,600 2.5 102 Chloride Group PLC Electronic and Electrical Equipment 1,513 2.4 326 Ten Largest Holdings 18,839 29.3 Genus PLC Pharmaceuticals and Biotechnology 1,474 2.3 316 NCC Group PLC Software and Computer Services 1,456 2.3 94 Albemarle and Bond Holdings PLC General Financials 1,445 2.3 110 London Capital Group PLC General Financials 1,383 2.1 100 James Halstead PLC Construction and Materials 1,365 2.1 223 Brewin Dolphin PLC General Financials 1,341 2.1 254 eaga PLC Support Services 1,329 2.0 368 Barr (AG) PLC Beverages 1,301 2.0 242 Domino Printing Sciences PLC Electronic and Electrical Equipment 1,259 2.0 205 Wilmington Group PLC Media 1,219 1.9 74 Care UK PLC Health Care Equipment and Services 1,204 1.9 155 Croda International PLC Chemicals 1,193 1.9 722 BSS Group PLC Support Services 1,138 1.8 356 Consort Medical PLC Health Care Equipment and Services 1,082 1.7 97 M.P. Evans Group PLC Food Producers 1,078 1.7 126 Mears Group PLC Support Services 1,044 1.6 161 Carclo PLC Chemicals 1,044 1.6 33 Phoenix IT Group PLC Software and Computer Services 1,044 1.6 109 Chemring Group PLC Aerospace and Defence 1,043 1.6 669 Booker Group PLC Food and Drug Retailers 1,026 1.6 402 Thirty Largest Holdings 43,307 67.4 Ultra Electronics Holdings PLC Aerospace and Defence 1,014 1.6 743 Victrex PLC Chemicals 977 1.5 421 Rensburg Sheppards PLC General Financials 972 1.5 176 Venture Production PLC Oil and Gas Producers 971 1.5 1,197 Mucklow (A&J) Group PLC Real Estate 962 1.5 130 Hill & Smith Holdings PLC Industrial Engineering 930 1.5 118 Caretech Holdings PLC Health Care Equipment and Services 918 1.4 135 Goals Soccer Centres PLC Travel and Leisure 891 1.4 61 WSP Group PLC Support Services 883 1.4 151 Primary Health Properties PLC Real Estate 858 1.3 82 Microgen PLC Software and Computer Services 840 1.3 38 VP Group PLC Support Services 834 1.3 65 RPS Group PLC Support Services 833 1.3 334 The Stanley Gibbons Group PLC General Retailers 831 1.3 23 Zytronic PLC Electronic and Electrical Equipment 818 1.3 17 TR Property Investment Trust PLC Real Estate 722 1.1 49 Hamworthy PLC Industrial Engineering 714 1.1 91 Dana Petroleum PLC Oil and Gas Producers 689 1.1 965 Dialight PLC Electronic and Electrical Equipment 683 1.1 36 Kewill PLC Software and Computer Services 623 1.0 28 Fifty Largest Holdings 60,270 93.9 Analysis of Investment Portfolio by Industrial or Commercial Sector as at 31 March 2009 Sector % of portfolio % of SmallCap Oil and Gas Producers 3.1 1.8 Oil Equipment Services and Distribution 0.0 0.0 Oil and Gas Total 3.1 1.8 Chemicals 5.0 1.3 Mining 0.0 2.2 Basic Materials Total 5.0 3.5 Aerospace and Defence 4.0 2.1 Construction and Materials 2.4 4.7 Electronic and Electrical Equipment 6.7 2.0 General Industrials 0.0 1.0 Industrial Engineering 2.8 4.6 Industrial Transportation 3.4 3.7 Support Services 22.4 17.3 Industrials Total 41.7 35.4 Automobiles and Parts 0.0 0.0 Beverages 2.0 0.0 Food Producers 1.7 3.1 Household Goods 0.0 1.7 Leisure Goods 0.1 0.6 Personal Goods 0.0 0.0 Consumer Goods Total 3.8 5.4 Health Care Equipment and Services 5.0 3.7 Pharmaceuticals and Biotechnology 6.3 4.9 Health-care Total 11.3 8.6 Food and Drug Retailers 1.6 0.3 General Retailers 7.2 4.2 Media 1.9 5.7 Travel and Leisure 5.6 5.9 Consumer Services Total 16.3 16.1 Fixed Line Telecommunications 0.0 0.6 Telecommunications Total 0.0 0.6 General Financial 8.0 6.2 Life Insurance 0.0 0.9 Non-life Insurance 0.0 0.9 Real Estate 4.6 12.8 Financials Total 12.6 20.8 Software and Computer Services 6.2 4.9 Technology, Hardware and Equipment 0.0 2.9 Technology Total 6.2 7.8 Total 100.0 100.0 The investment portfolio comprises 61 listed UK equity holdings including 12 holdings totalling Â£12,541,000 (representing 20% of the portfolio) traded on the Alternative Investment Market ("AIM"). Directors' Report The Directors present their Annual Report and financial statements for the year ended 31 March 2009. Business Review Introduction The purpose of the Business Review is to provide an overview of the business of the Company by: - Analysing development and performance using appropriate key performance indicators (`KPIs') - Outlining the principal risks and uncertainties affecting the Company - Describing how the Company manages these risks - Explaining the future business plans of the Company - Setting out the Company's environmental, social and ethical policy as disclosed on page 17 - Providing information about persons with whom the Company has contractual or other arrangements which are essential to the business of the Company - Outlining the main trends and factors likely to affect the future development, performance and position of the Company's business. DEVELOPMENT, PERFORMANCE AND POSITION OF MUSCIT Review of the Business of MUSCIT A description of MUSCIT's activities during the year is given in the Chairman's Statement on page 2 and in the portfolio management section of the Manager's Report. MUSCIT is a closed-end investment trust listed on the London Stock Exchange. Its affairs are managed so that it receives approval from HM Revenue & Customs as an investment trust under s842 of the Income & Corporation Taxes Act 1988 ("s842"). One of the criteria for compliance is that at least 85% of MUSCIT's eligible investment income arising in an accounting period is distributed to shareholders. The Board considers that MUSCIT will continue to qualify as an investment trust, which confers certain benefits such as exemption from the payment of capital gains taxes arising on the sale of investments. MUSCIT has most recently received approval under s842 for the year ended 31 March 2008 and an application will be made to HM Revenue & Customs for MUSCIT's status as an investment trust in financial year 2008/09 to be confirmed. Further details on the operation of investment trusts can be obtained from the Association of Investment Companies on their website at www.theaic.co.uk. MUSCIT is also an investment company as defined in s833 of the Companies Act 2006. The current portfolio of MUSCIT is such that its shares are eligible for inclusion in an ISA and PEPs up to the maximum annual subscription limit and the Directors expect this eligibility to be maintained. MUSCIT's investment objective is capital appreciation (rather than income) achieved by investing in quoted companies listed on the London Stock Exchange or traded on the Alternative Investment Market ("AIM"). No unquoted investments are permitted. The benchmark is the FTSE SmallCap (excluding investment companies) Index. At the time of initial investment, a potential investee company must be profitable and smaller than the largest constituent of the HGSC Index which represents the smallest 10% of the UK Stock Market by value. At the start of 2009, this was any company below Â£911 million in size. The Manager of MUSCIT is Montanaro Investment Managers Limited ("Montanaro"), a highly experienced specialist in UK and European quoted small companies established in 1991. Montanaro has one of the largest teams in the UK researching and investing exclusively in quoted small companies. They closely monitor all investments within the portfolio and identify potential new investments. Although sector weightings of the benchmark are monitored, the portfolio is a result of bottom up stock picking and may differ markedly from the index. Tracking error may be relatively high reflecting a focus on research driven stock selection. Montanaro currently manage over Â£500 million, mainly on behalf of leading financial institutions. There are currently 33,475,958 ordinary 10p shares in issue (2008: 35,449,458) of which none are held in Treasury (2008: 1,828,000). Holders of ordinary shares have unrestricted voting rights at all general meetings of the Company. Details of the shares bought back during the year are contained in the Chairman's Statement on page 2 and in Note 15. Description of Principal Risks Associated with MUSCIT The Board carefully considers the principal risks for MUSCIT and seeks to manage these risks through continual and regular review, policy setting, compliance with and enforcement of contractual obligations and active communication with the Manager, the Administrator and shareholders. The Board applies the principles detailed in the recommendations of the AIC Code as described elsewhere in the Directors' Report. Details of MUSCIT's internal controls may be found under Corporate Governance. Mitigation of the principal risks is sought and achieved in many ways as shown in italics below: Investment Manager: Montanaro has been the Manager of MUSCIT since its launch in 1995. The success of MUSCIT and its strong performance is largely attributable to Montanaro. Should the current Manager not be in a position to continue its management of the Company, performance may be impacted. The Board holds board meetings which are attended by the Manager. Montanaro have one of the largest specialist teams in the UK. Succession planning within Montanaro and recruitment of personnel are closely monitored. Investment & Strategy: MUSCIT may underperform its benchmark as a result of poor stock selection or sector allocation or as a result of being geared in a falling market. The Manager meets regularly with the Board to discuss portfolio performance and strategy, and provides the Board and shareholders with monthly reports. The portfolio is well diversified thereby reducing stock specific risk. The Board receives and reviews monthly a report of all transactions and, through the forum of its Management Engagement Committee, formally reviews the performance of the Manager annually. Gearing: one of the benefits of closed ended investment trusts is the ability to use borrowings which can enhance returns in a rising stock market. However, gearing exacerbates movements in the net asset value both positively and negatively and will exaggerate declines in net asset value when prices of quoted UK small companies are falling. The Board monitors and discusses with the Manager the appropriate level of gearing of MUSCIT at each Board meeting. Portfolio Liquidity: as with all small company investment trusts, there are times when the liquidity of the underlying portfolio is poor, such as when small company trusts are out of favour or during periods of adverse economic conditions. The Manager focuses on Smaller Companies where the opportunities may be more attractive but this can increase overall underlying illiquidity. This may result in the Manager being unable to buy or sell individual holdings within the portfolio. In addition, this may impact the discount of MUSCIT to the net asset value of the portfolio. One of the benefits of a closed end investment trust is that the Manager is not forced to buy or sell individual holdings at inopportune times. The Manager constantly reviews the underlying liquidity of the portfolio, which is well-diversified. Particular attention is paid to the AIM holdings, with the Manager providing the Board with liquidity reports at every meeting. Montanaro deal with a wide range of brokers to enhance their ability to execute and minimise liquidity risk. Liquidity of MUSCIT Shares: as with many small company investment trusts, there are times when the liquidity of the shares of MUSCIT is low. In the case of MUSCIT, many of the shareholders are large financial institutions with a long-term investment horizon. Unlike other trusts where private individuals form a larger part of the share register, this may result in less shares being traded in MUSCIT on a daily basis and make it difficult at times for investors to buy or sell shares of MUSCIT. The Manager is encouraged by the Board to market the strong investment story of MUSCIT to private client wealth managers and other potential new investors. The goal is to widen the shareholder base to enhance liquidity. In addition, the ability to buy back shares to be held in Treasury for subsequent re-issue enhances the liquidity of MUSCIT shares. Discount Volatility: as with all small company investment trusts, discounts can fluctuate significantly both in absolute terms and relative to their peer group. The Board actively monitors and seeks to manage the discount of MUSCIT and is responsible for share buy backs for cancellation or issuance from Treasury. Share buy backs may help to reduce the discount. During the year and up to the date of this report, MUSCIT has made use of the authority granted at the Annual General Meeting held in 2008 to make market purchases of up to 5,313,874 ordinary shares and as at the date of this report has the authority to purchase 5,263,374ordinary shares. No ordinary shares are currently held in Treasury. 145,500 Ordinary shares were bought back for cancellation during the year. The Board encourages the Manager to market MUSCIT to new investors to increase demand for shares of MUSCIT, which may help to reduce the discount. Regulatory: a breach of s842 might lead to MUSCIT being subject to capital gains tax; a breach of rules of the London Stock Exchange might result in censure by the FSA and/or suspension of MUSCIT's listing on the London Stock Exchange. The Board has agreed a service level agreement with the Administrator which includes active and regular review of compliance with s842, and FSA and London Stock Exchange Rules. This is reviewed at each Board meeting. Operational: if the Administrator's operational procedures proved deficient and its core accounting systems failed, accounting errors might occur resulting in inaccurate net asset valuations and performance data and possibly a qualified audit report and/or loss of s842 status. The Board monitors operational issues monthly and reviews them in detail at each Board meeting. Financial: inappropriate accounting policies or failure to comply with current or new Accounting Standards might lead to a breach of regulations and/or loss of s842 status. The Board monitors financial issues monthly and reviews them in detail at each Board meeting. Banking: a breach of MUSCIT's loan covenants might lead to funding being summarily withdrawn and investment holdings potentially being sold at a time of poor liquidity. The main financial covenants to which the Company is subject in respect of the ING N.V. revolving credit facility require it to ensure that total borrowings will not exceed 30% of the adjusted Net Asset Value at any time and that the adjusted Net Asset Value does not fall below Â£39,000,000 at any time. The Board monitors compliance with banking covenants monthly and reviews them with the Administrator and Manager. Reputational: inadequate or deficient controls of the Administrator or Manager or other third-party providers might result in breaches of regulations and damage the trust and confidence of shareholders in MUSCIT, leading to a widening of the discount. The Board continually monitors and reviews issues that may impact the standing of MUSCIT. Reputational: Failure to keep current and potential investors informed of the Trust's performance and development could result in less shares being traded in MUSCIT on a daily basis and also lower investor confidence. The Board and Manager maintain clear and frequent communication with shareholders and potential investors. The Board and Manager are happy to meet with shareholders. Company Viability: Through falling NAV, or a reduction in the size of the Company through repurchases of its own shares, the size of the Company could make the continuing existence of the Company unviable in the opinion of investors. The Board actively monitors and seeks to manage the discount of MUSCIT and is responsible for share buy backs for cancellation or holding in Treasury. The resultant size of the Company is an important consideration of the decision to undertake buy backs. The Board regularly reviews the performance of the Company and the strategy of the Manager is reviewed at each Board meeting. A description of MUSCIT's system for reviewing its risk-environment is shown in the Directors' Report. Statement of Directors' Responsibilities in Respect of the Annual Report and the Financial Statements The Directors are responsible for preparing the Annual Report and the financial statements in accordance with applicable law and regulations. Company law requires the Directors to prepare financial statements for each financial year. Under that law they have elected to prepare the financial statements in accordance with UK Accounting Standards and applicable law (UK Generally Accepted Accounting Practice). The financial statements are required by law to give a true and fair view of the state of affairs of the Company and of the profit or loss of the Company for that period. In preparing these financial statements, the Directors are required to: - select suitable accounting policies and then apply them consistently; - make judgments and estimates that are reasonable and prudent; - state whether applicable UK Accounting Standards have been followed, subject to any material departures disclosed and explained in the financial statements; and - prepare the financial statements on the going concern basis unless it is inappropriate to presume that the Company will continue in business. The Directors are responsible for keeping proper accounting records that disclose with reasonable accuracy at any time the financial position of the Company and enable them to ensure that its financial statements comply with the Companies Act 1985. They have general responsibility for taking such steps as are reasonably open to them to safeguard the assets of the Company and to prevent and detect fraud and other irregularities. Under applicable law and regulations, the Directors are also responsible for preparing a Directors' Report, Directors' Remuneration Report and Corporate Governance Statement that comply with that law and those regulations. The Directors are responsible for the maintenance and integrity of the corporate and financial information included on the company's website, www.montanarouksmaller.co.uk. Legislation in the UK governing the preparation and dissemination of financial statements may differ from legislation in other jurisdictions. Responsibility statement of the Directors in respect of the annual financial report We confirm that to the best of our knowledge: - the financial statements, prepared in accordance with the applicable set of accounting standards, give a true and fair view of the assets, liabilities, financial position and profit or loss of the Company; and - the Directors' Report includes a fair review of the development and performance of the business and the position of the issuer, together with a description of the principal risks and uncertainties that they face. DAVID GAMBLE Chairman 10 June 2009 Income Statement for the year to 31 March 2009 Year to 31 March 2009 Year to 31 March 2008 Revenue Capital Total Revenue Capital Total Notes Â£000 Â£000 Â£000 Â£000 Â£000 Â£000 Losses on investments designated as fair value through profit or loss 10 - (37,641) (37,641) - (22,427) (22,427) Dividends and interest 2 2,855 - 2,855 2,823 - 2,823 Management fee* 3 26 (61) (35) (716) (717) (1,433) Management performance fee* 3 - 247 247 - - - Other income 2 184 - 184 5 - 5 Other expenses 4 (334) - (334) (312) - (312) Net return before finance costs and taxation 2,731 (37,455) (34,724) 1,800 (23,144) (21,344) Interest payable and similar charges 6 (266) (266) (532) (442) (442) (884) Net return before taxation 2,465 (37,721) (35,256) 1,358 (23,586) (22,228) Taxation 7 - - - - - - Net return after taxation 2,465 (37,721) (35,256) 1,358 (23,586) (22,228) Return per ordinary share 9 7.36p (112.54p) (105.18p) 3.82p (66.30p) (62.48p) The total column of this statement is the profit and loss account of the Company. All revenue and capital items in the above statement derive from continuing operations. No Statement of Total Recognised Gains and Losses has been prepared as all such gains and losses are shown in the Income Statement. No operations were acquired or discontinued in the year. * net of VAT refund. The notes below form part of these financial statements. Reconciliation of Movements in Shareholders' Funds for the year to 31 March 2009 Called-up Share Capital Own shares Total equity share premium redemption Special Capital Revenue held in shareholders' capital account reserve reserve reserve reserve Treasury funds Year to 31 March 2009 Notes Â£000 Â£000 Â£000 Â£000 Â£000 Â£000 Â£000 Â£000 As at 31 March 2008 3,545 19,307 1,165 9,451 71,169 2,247 (4,501) 102,383 Fair value movement of investments 10 - - - - (37,641) - - (37,641) Costs allocated to capital - - - - (80) - - (80) Dividends paid in the year 8 - - - - - (1,227) - (1,227) Shares purchased for cancellation (14) - 14 (308) - - - (308) Treasury shares cancelled (183) - 183 (4,501) - - 4,501 - Net revenue for the year - - - - - 2,465 - 2,465 As at 31 March 2009 3,348 19,307 1,362 4,642 33,448 3,485 - 65,592 Called-up Share Capital Own shares Total equity share premium redemption Special Capital Revenue held in shareholders' capital account reserve reserve Reserve reserve Treasury funds Year to 31 March 2008 Â£000 Â£000 Â£000 Â£000 Â£000 Â£000 Â£000 Â£000 As at 31 March 2007 3,561 19,307 1,149 9,835 94,755 1,833 - 130,440 Fair value movement of investments 10 - - - - (22,427) - - (22,427) Costs allocated to capital - - - - (1,159) - - (1,159) Dividends paid in the year 8 - - - - - (944) - (944) Shares purchased for cancellation (16) - 16 (384) - - - (384) Shares purchased for Treasury - - - - - - (4,501) (4,501) Net revenue for the year - - - - - 1,358 - 1,358 As at 31 March 2008 3,545 19,307 1,165 9,451 71,169 2,247 (4,501) 102,383 The notes below form part of these financial statements. Balance Sheet as at 31 March 2009 31 March 2009 31 March 2008 Notes Â£000 Â£000 Â£000 Â£000 Fixed assets Investments designated at fair value through profit or loss 10 64,207 106,154 Current assets Debtors 12 344 460 Cash at bank 20 6,167 11,243 6,511 11,703 Creditors: amounts falling due within one year Other creditors 13 (126) (474) Revolving credit facility 14 (5,000) (15,000) (5,126) (15,474) Net current assets/(liabilities) 1,385 (3,771) Total assets less current liabilities 65,592 102,383 Net assets 65,592 102,383 Share capital and reserves Called-up share capital 15 3,348 3,545 Share premium account 19,307 19,307 Capital redemption reserve 1,362 1,165 Special reserve 4,642 9,451 Capital reserve 33,448 71,169 Revenue reserve 3,485 2,247 Own shares held in Treasury - (4,501) Total equity shareholders' funds 65,592 102,383 Net asset value per ordinary share 18 195.94p 304.52p These financial statements were approved by the Board of Directors on 10 June 2009. DAVID GAMBLE ANTONY HARDY The notes below form part of these financial statements. Statement of Cash Flows for the year to 31 March 2009 31 March 2009 31 March 2008 Notes Â£000 Â£000 Â£000 Â£000 Operating activities Investment income received 2,652 2,604 Deposit interest received 313 177 Management fees paid (960) (2,059) Company secretarial fees paid (79) (63) VAT and interest reclaimed on investment management fees 2/3 1,313 - Other cash expenses (257) (529) Net cash inflow from operating activities 19 2,982 130 Servicing of finance Interest and similar charges paid (686) (802) Net cash outflow from servicing of finance (686) (802) Capital expenditure and financial investment Purchases of investments (14,400) (28,763) Sales of investments 18,563 37,647 Net cash inflow from investing activities 4,163 8,884 Equity dividends paid (1,227) (944) Net cash inflow before financing 5,232 7,268 Financing (Repayment)/proceeds of short-term credit facility (10,000) 4,500 Ordinary shares purchased for cancellation (308) (384) Ordinary shares purchased for Treasury - (4,501) Net cash outflow from financing (10,308) (385) (Decrease)/increase in cash 20 (5,076) 6,883 The notes below form part of these financial statements. Notes to the Financial Statements at 31 March 2009 1 Accounting Policies Accounting Convention The financial statements are prepared under the historical cost convention as modified by the revaluation of fixed asset investments and in accordance with UK applicable accounting standards and the Statement of Recommended Practice regarding the Financial Statements of Investment Trust Companies and Venture Capital Trusts ("SORP") issued in January 2009 and adopted early. The early adoption of this SORP had no effect on the financial statements of the Company other than the requirement to separately disclose capital reserves that relate to the revaluation of investments held at the Balance Sheet date. This new requirement replaces the requirement to disclose the value of the capital reserve that is unrealised. All the Company's activities are continuing. A resolution to release the Directors from the requirement of holding a continuation vote in 2010, as required by the Articles of Association, will be put to shareholders at the Annual General Meeting as outlined in the Notice of Annual General Meeting in the full annual report. Income Recognition UK dividend income is included in the financial statements when the investments concerned are quoted ex-dividend and shown net of any associated tax credit. Deposit interest and underwriting commissions receivable are included on an accruals basis. Management Expenses and Finance Costs Management fees and finance costs are allocated 50% to the capital reserve and 50% to the revenue account. This is in line with the Board's expectations of long-term returns from the investment portfolio of the Company. Performance fees are charged 100% to capital. Costs arising on early settlement of debt are allocated 100% to capital, in accordance with the requirements of the SORP. All other expenses are allocated in full to the revenue account. Investments Investments are recognised and derecognised on the trade date where a purchase or sale is under a contract whose terms require delivery within the time frame established by the market concerned, and are initially measured at fair value. All investments held by the Company are classified as at "fair value through profit or loss". Investments are initially recognised at cost, being the fair value of the consideration given. After initial recognition investments are measured at fair value, with unrealised gains and losses on investments and impairment of investments recognised in the Income Statement and allocated to capital. For investments actively traded in organised financial markets, fair value is generally determined by reference to Stock Exchange quoted market bid prices at the close of business on the balance sheet date, without adjustment for transaction costs necessary to realise the asset. Treasury Shares The consideration paid for shares held in Treasury is presented as a deduction from equity shareholders' funds, in accordance with FRS 25: "Financial Instruments: Disclosure and Presentation". Any profit on the sale of shares out of Treasury is credited to the share premium account in full. Taxation The charge for taxation is based on the net revenue for the year. Deferred taxation is provided in accordance with FRS 19: Deferred Taxation, on all timing differences that have originated but not reversed by the balance sheet date. Deferred taxation assets are only being recognised to the extent that they are regarded as recoverable. Dividends Payable to Shareholders In accordance with FRS 21: "Events after the Balance Sheet date", dividends to shareholders are recognised as a liability in the period in which they have been declared. Therefore, any interim dividends are not accounted for until paid, and final dividends are accounted for when approved by shareholders at an annual general meeting. Bank loans and borrowings All bank loans and borrowings are initially recognised at cost, being the fair value of the consideration received, less issue costs where applicable. After initial recognition, all interest bearing loans and borrowings are subsequently measured at amortised cost. Any differences between cost and redemption value is recognised in the Income Statement over the period of the borrowings on an effective interest basis. CAPITAL RESERVES In accordance with the guidance given in the AIC SORP issued January 2009 the capital reserve is not separated into realised and unrealised. Therefore gains and losses on realisation of investments and changes in fair value of investments are shown in one reserve. 2 Income Year to Year to 31 March 2009 31 March 2008 Â£000 Â£000 Income from investments 2,608 2,628 UK dividend income 2,608 2,628 Other income Interest received on Investment Management fees reclaimed VAT 181 - Bank interest 247 195 Underwriting commission 3 5 Total income 3,039 2,828 Total income comprises Dividends from financial assets 2,608 2,628 designated at fair value through profit or loss Interest from financial assets 247 195 designated at fair value through profit or loss Dividends and interest 2,855 2,823 Interest received on Investment Management 181 - fees reclaimed VAT Other income not from financial assets 3 5 Other income 184 5 3,039 2,828 All investment income has been obtained from investments listed in the UK. 3 Management Fee Year to 31 March 2009 Year to 31 March 2008 Revenue Capital Total Revenue Capital Total Â£000 Â£000 Â£000 Â£000 Â£000 Â£000 Management fee 460 460 920 664 664 1,328 Irrecoverable VAT thereon - - - 52 53 105 VAT reclaimed on Investment Management fees (486) (399) (885) - - - (26) 61 35 716 717 1,433 Performance fee - - - - - - Irrecoverable VAT thereon - - - - - - VAT reclaimed on Performance fees - (247) (247) - - - - (247) (247) - - - The Manager receives a monthly fee equivalent to 1/12 of 1.0% of the gross assets of the Company valued at the close of business on the last business day of each month and is entitled to a performance fee calculated as described in the Directors' Report above. At 31 March 2009, Â£58,000 (2008: Â£98,000) was due for payment to the Manager. The Company ceased to pay VAT on its Manager's fees from 10 October 2007 as a result of the AIC/Claverhouse ruling. The refund of VAT in respect of performance fees relates to fees paid in 2007, 2006 and 2001. 4 Other Expenses Year to Year to 31 March 2009 31 March 2008 Â£000 Â£000 Administration and company secretarial fees 79 63 Auditor's remuneration (also see * below) for: - audit 20 20 - other services to the Company 5 3 Other expenses (including Directors' remuneration and VAT) 230 226 334 312 * Total fees paid to the Auditor for the year, all of which were charged to revenue, comprised: Audit services - statutory audit 20 20 Tax services - compliance services 5 3 25 23 The Directors do not consider that the provision of non-audit work to the Company affects the independence of the Auditor. 5 Directors' Remuneration Year to Year to 31 March 2009 31 March 2008 Â£000 Â£000 Total fees 85 85 A breakdown of the Directors' remuneration is set out in the Directors' Remuneration Report. The Company has no employees. 6 Interest Payable and Similar Charges Year to 31 March 2009 Year to 31 March 2008 Revenue Capital Total Revenue Capital Total Financial liabilities not at fair value through profit or loss Â£000 Â£000 Â£000 Â£000 Â£000 Â£000 Interest payable on loan 266 266 532 442 442 884 266 266 532 442 442 884 7 Taxation The current taxation for the year is different to the standard rate of corporation tax in the UK of 28% (2008: 30%). A reconciliation is provided below: Year to Year to 31 March 2009 31 March 2008 (restated) Â£000 Â£000 Return on ordinary activities before taxation (35,256) (22,228) Theoretical corporation tax at 28% (2008: 30%) (9,872) (6,668) Effects of: - Capital losses that are not taxable 10,539 6,728 - UK dividend income not liable to corporation tax (730) (788) - expenses disallowed for taxation purposes 9 6 - excess management expenses 54 722 Current taxation charge - - At 31 March 2009, the Company had surplus management expenses and non-trade losses of Â£20,575,810 (2008: Â£20,383,984), which have not been recognised as a deferred taxation asset. This is because the Company is not expected to generate taxable income in future periods in excess of the deductible expenses of those future periods and, accordingly, it is unlikely that the Company will be able to reduce future taxation through the use of existing surplus expenses. Due to the Company's status as an Investment Trust and the intention to continue meeting the conditions required to obtain approval in the foreseeable future, the Company has not provided deferred tax on any capital gains and losses arising on the revaluation or disposal of investments. 8 Dividends Year to Year to 31 March 2009 31 March 2008 Â£000 Â£000 Paid 2008 Final dividend of 3.65p (2007: 2.65p) per ordinary share 1,227 944 Proposed 2009 Final dividend of 6.85p* (2008: 3.65p) per ordinary share 2,293 1,227 * Including a non-recurring element of 1.99p 9 Return per Share Year to 31 March 2009 Year to 31 March 2008 Revenue Capital Total Revenue Capital Total Ordinary share 7.36p (112.54p) (105.18p) 3.82p (66.30p) (62.48p) Revenue return per ordinary share is based on the net revenue after taxation of Â£2,465,000 (2008: Â£1,358,000) and 33,518,244 (2008: 35,576,425) ordinary shares, being the weighted average number of ordinary shares, excluding any shares held in Treasury. Capital return per ordinary share is based on net capital losses for the year of Â£37,721,000 (2008: Â£23,586,000), and on 33,518,244 (2008: 35,576,425) ordinary shares, being the weighted average number of ordinary shares, excluding any shares held in Treasury. 10 Investments Year to 31 March 2009 Year to 31 March 2008 Â£000 Â£000 Total investments at fair value 64,207 106,154 The investment portfolio comprises 61 listed UK equity holdings including 12 holdings totalling Â£12,541,000 (representing 20% of the portfolio) traded on the Alternative Investment Market ("AIM"). Year Year to to 31 March 2009 31 March 2008 Â£000 Â£000 Opening book cost 90,403 89,192 Opening fair value adjustment 15,751 48,250 Opening valuation 106,154 137,442 Movements in the year Purchases at cost 14,251 28,234 Sales - proceeds (18,557) (37,095) Sales - (losses)/ gains on sales (5,107) 10,072 Changes in fair value (32,534) (32,499) Closing valuation 64,207 106,154 Closing book cost 80,990 90,403 Closing fair value adjustment (16,783) 15,751 64,207 106,154 TRANSACTION COSTS During the year, the Company incurred transaction costs of Â£95,000 (2008: Â£183,000) and Â£27,000 (2008: Â£59,000) on purchases and sales of investments, respectively. These amounts are deducted in determining losses on investments at fair value as disclosed in the Income Statement. 31 March 31 March 2009 2008 Total Total `000 `000 Net losses on investments at fair value though profit or loss (Losses)/gains on (5,107) 10,072 sales Changes in fair (32,534) (32,499) value (37,641) (22,427) A list of the top 50 investments by market value and an analysis of the investment portfolio by industrial or commercial sector are set out at the beginning of the report. 11 Significant Holdings The Company has a holding of 3% or more of the voting rights attached to shares that is material in the context of the accounts in the following investments: % of Voting Security rights Zytronic PLC 4.7 The Stanley Gibbons Group PLC 3.6 Lok'n Store Group PLC 3.3 Latchways PLC 3.2 Carclo PLC 3.1 12 Debtors 31 March 2009 31 March 2008 Â£000 Â£000 Prepayments and accrued income 42 114 Dividends receivable 302 346 344 460 The carrying amount for prepayments, accrued income and dividends receivable disclosed above reasonably approximates to its fair value at the year end and is expected to be realised within a year from the balance sheet date. 13 Other Creditors 31 March 2009 31 March 2008 Â£000 Â£000 Accruals and deferred income 126 474 126 474 The carrying amount for accruals and deferred income disclosed above reasonably approximates to its fair value at the year end and is expected to be realised within a year from the balance sheet date. 14 Revolving Credit Facility 31 March 2009 31 March 2008 Â£000 Â£000 Falling due within one year 5,000 15,000 Falling due after more than one year - - 5,000 15,000 The Company has a Â£15,000,000 Revolving Credit Facility with ING Bank N.V. As at 31 March 2009, Â£5,000,000 was drawn down (31 March 2008: Â£15,000,000), all of which has a fixed interest rate of 2.69%* and is repayable on 11 September 2009. The remaining Â£10,000,000 remains undrawn. * Including margin and mandatory costs. 15 Share Capital 31 March 2009 31 March 2008 Â£000 Â£000 Authorised: 82,101,048 (2008: 82,101,048) ordinary shares of 10p each 8,210 8,210 Allotted, called-up and fully paid*: 33,475,958 (2008: 35,449,458) ordinary shares of 10p each 3,348 3,545 * including shares held in Treasury. Voting rights Ordinary shareholders have unrestricted voting rights at all general meetings of the Company. At the Annual General Meeting on 18 July 2008 the Company was granted the authority to repurchase 5,313,874 ordinary shares. As at 31 March 2009 the Company had remaining authority to repurchase 5,168,374 ordinary shares. This authority is due to expire at the conclusion of the next Annual General Meeting to be held on 31 July 2009. During the year the following shares were purchased for cancellation: % of issued share Total capital cost of Number of as at purchase date of including ordinary shares purchased purchase expenses Date Â£000 11/07/2008 30,000 0.08 65 14/07/2008 30,000 0.08 65 15/07/2008 25,000 0.07 54 16/07/2008 10,000 0.03 21 18/07/2008 50,500 0.14 103 145,500 308 On 10 December 2008 1,828,000 shares held in Treasury were cancelled. The Company does not have any externally imposed capital requirements. The capital of the Company is managed in accordance with its investment policy in pursuit of its investment objectives, both of which are detailed above. 16 Duration of the Company The Articles of Association prescribe that shareholders should have the opportunity to consider the future of the Company at regular intervals. At the Annual General Meeting to be held on 31 July 2009 an Ordinary Resolution will be proposed to release the Directors from the obligation to convene a General Meeting during 2010 for the purpose of voluntarily winding up the Company, as provided for in the Company's Articles of Association. If the Company is not wound up, such Resolution will be proposed at a General Meeting every five years thereafter unless, at any AGM held within, and not more than, 18 months prior to the expiry of the relevant period of five years, an Ordinary Resolution is passed releasing the Directors from the obligation to convene such a General Meeting. 17 Own Shares Held in Treasury The Company has taken advantage of the regulations which came into force on 1 December 2003 to allow companies, including investment trusts, to buy its own shares and hold them in Treasury for re-issue at a later date. The shares previously held in Treasury were cancelled on 10 December 2008. No shares were placed in Treasury during the year. The maximum number of shares held at any time during the year was 1,828,000, representing 5.18% of the issued Capital. Year to 31 March 2009 Year to 31 March 2008 Own shares Premium on Own shares Premium on held in Treasury disposal held in Treasury disposal SUMMARY Number Â£000 Â£000 Number Â£000 Â£000 At 1 April 1,828,000 4,501 - - - - Additions - - - 1,828,000 4,501 - Cancellation - book cost (1,828,000) (4,501) - - - - Disposals - book cost - - - - - - At 31 March - - - 1,828,000 4,501 - 18 Net Asset Value per Ordinary Share Net asset value per ordinary share is based on net assets of Â£65,592,000 (2008: Â£102,383,000) and on 33,475,958 (2008: 33,621,458) ordinary shares being the number of ordinary shares in issue at the year end. 19 Reconciliation of Net Revenue Before Finance Costs and Taxation to Net Cash Inflow from Operating Activities Year to 31 March 2009 Year to 31 March 2008 Â£000 Â£000 Net revenue before finance costs and taxation 2,731 1,800 Management fee charged to capital (460) (717) VAT reclaim on Investment Management Fees charged to capital 646 - Decrease in creditors (45) (910) Decrease/(increase) in prepayments and accrued income 110 (43) Net cash inflow from operating activities 2,982 130 20 Reconciliation of Net Cash Flows to Movements in Net Cash/(Debt) Year to 31 March 2009 Year to 31 March 2008 Â£000 Â£000 (Decrease)/increase in cash in year (5,076) 6,883 Proceeds of credit facility - (4,500) Repayment of credit facility 10,000 - Movement in net funds 4,924 2,383 Net debt at beginning of year (3,757) (6,140) Net cash/(debt) at end of year 1,167 (3,757) ANALYSIS OF NET CASH/(DEBT) 1 April 2008 Cash flows 31 March 2009 Â£000 Â£000 Â£000 Cash at bank 11,243 (5,076) 6,167 Debt due in less than one year (15,000) 10,000 (5,000) Debt due after one year - - - (3,757) 4,924 1,167 21 Analysis of Financial Assets and Liabilities As required by FRS 29: "Financial Instruments: Disclosures", an analysis of financial assets and liabilities, which identifies the risk to the Company of holding such items, is given below. BACKGROUND The Company's financial instruments comprise securities, cash balances and debtors and creditors that arise from its operations, for example, in respect of sales and purchases awaiting settlement and debtors for accrued income. The risk management policies and procedures outlined in this note have not changed substantially from the previous accounting period. The Company has little or no exposure to cash flow or foreign currency risk. The principal risks the Company faces in its portfolio management activities are: - credit risk; - market price risks, i.e. movements in the value of investment holdings caused by factors other than interest rate or currency movement; - interest rate risk; - liquidity risk i.e. the risk that the Company has difficulty in realising assets or otherwise raising funds to meet commitments associated with financial instruments; and - gearing. The Manager monitors the financial risks affecting the Company on a daily basis. The Directors receive financial information on a monthly basis which is used to identify and monitor risk. (i) Credit Risk Credit risk is the risk of financial loss to the Company if the contractual party to a financial instrument fails to meet its contractual obligations. The carrying amounts of financial assets best represent the maximum credit risk exposure at the balance sheet date. The Company's listed investments are held on its behalf by HSBC acting as agent, the Company's custodian. Bankruptcy or insolvency of the custodian may cause the Company's rights with respect to securities held by the custodian to be delayed. The Board monitors the Company's risk by reviewing the custodian's internal controls reports. Investment transactions are carried out with a large number of brokers whose creditworthiness is reviewed by the Manager. Transactions are ordinarily undertaken on a delivery versus payment basis whereby the Company's custodian bank ensures that the counterparty to any transaction entered into by the Company has delivered in its obligations before any transfer of cash or securities away from the Company is completed. The banks at which cash is held are under constant review. The maximum exposure to credit risk at 31 March 2009 was: 31 March 2009 31 March 2008 Â£000 Â£000 Cash at bank 6,167 11,243 Debtors and prepayments 344 460 6,511 11,703 None of the Company's assets are past due or impaired. (ii) Market Price Risk Market price risk arises mainly from uncertainty about future prices of financial instruments. The value of shares and the income from them may fall as well as rise and shareholders may not get back the full amount invested. The Manager continues to monitor the prices of financial instruments held by the Company on a real time basis. Adherence to the Company's investment objectives mitigates the risk of excessive exposure to one issuer or sector. The Board manages the market price risks inherent in the investment portfolio by ensuring full and timely access to relevant information from the Investment Manager. The Board meets regularly and each meeting reviews the investment performance, the investment portfolio and the rationale for the current investment positioning to ensure consistency with the Company's objectives and investment policies. The portfolio does not seek to reproduce the index, investments are selected based upon the merit of individual companies and therefore the portfolio may well diverge from the short term fluctuations of the benchmark. Fixed asset investments are valued at their bid price which equates to their fair value. A list of the Company's 50 largest equity investments shown at beginning of announcement. In addition, an analysis of the investment portfolio by broad industrial and commercial sector, an analysis of the portfolio by market capitalisation of holdings and a list of the 30 largest equity investments are contained in the Managers' Review section. The maximum exposure to market price risk is the fair value of investments of Â£64,207,000 (2008: Â£106,154,000). If the investment portfolio valuation fell by 1% from the amount detailed in the financial statements as at 31 March 2009 it would have the effect, with all other variables held constant, of reducing the net capital return before taxation by Â£642,000 (2008: Â£1,062,000). An increase of 1% in the investment portfolio valuation would have an equal and opposite effect on the net capital return before taxation. (iii) Interest Rate Risk Changes in interest rates may cause fluctuations in the income and expenses of the Company. The revolving credit facility with ING Bank N.V. is a fixed rate facility (see note 14). The amount of such borrowings and the approved levels are monitored and reviewed regularly by the Board. The Company mitigates the risk by fixing the interest rates of the facility for six months at a time. The Company receives interest on the cash deposits at a rate of 0.5% below the bank base rate. The interest received in the year amounted to Â£247,000 (2008: Â£195,000). The interest risk profile of the Company is given below. If interest rates had reduced by 1% from those paid as at 31 March 2009 it would have the effect, with all other variables held constant, of increasing the net revenue return before taxation on an annualised basis by Â£50,000 (2008: Â£150,000). If there was an increase in interest rates of 1% there would have been an equal and opposite effect in the net revenue return before taxation. The calculations are based on cash at bank and short-term deposits as at 31 March 2009 and these may not be representative of the year as a whole. Due to the short-term nature of the loan facility, changes in interest rates would not have an effect on the fair value of the loan. (iv) Liquidity Risk Liquidity is the risk that the Company will encounter difficulty in meeting obligations associated with financial liabilities. The Manager does not invest in unlisted securities on behalf of the Company. However, the investments held by the Company consist of UK quoted small companies which are inherently less liquid than quoted large companies. Short-term flexibility is achieved through the use of bank borrowings. Liquidity risk is mitigated by the fact that the Company has Â£6.2 million cash at bank which can satisfy its creditors and that as a closed end fund assets do not need to be liquidated to meet redemptions. (v) Gearing Gearing can have amplified effects on the net asset value of the Company. It can have a positive or negative effect depending on market conditions. It is the Company's policy to determine the adequate level of gearing appropriate to its own risk profile. (vi) Use of Derivatives It is not the Company's policy to enter into derivative contracts. FINANCIAL ASSETS The majority of the Company's financial assets are listed equity shares which neither pay interest nor have a maturity date. No fixed interest assets were held at 31 March 2009 nor during the year. All financial assets are in sterling and disclosed at fair value through profit or loss. FINANCIAL LIABILITIES The Company finances its operations through equity, retained profits and bank borrowings (see note 14). The change in the fair value of financial liabilities during the year was not related to the credit risk profile. The interest rate risk profile of the financial liabilities of the Company as at 31 March 2009 is as follows: Weighted average Period until Total interest rate maturity Â£000 % Years Amounts drawn down under fixed revolving credit facility 5,000 5.5338 0.45 Financial liabilities upon which no interest is paid 126 - - The interest rate risk profile of the financial liabilities of the Company as at 31 March 2008 was as follows: Total Weighted average Period until Â£000 interest rate maturity % Years Amounts drawn down under fixed revolving credit facility 15,000 6.1203 0.33 Financial liabilities upon which no interest is paid 474 - - The maturity profile of the Company's financial liabilities is as follows: As at 31 March 2009 As at 31 March 2008 Â£000 Â£000 In one year or less 5,126 15,474 In more than one but not more than two years - - In more than two years but not more than five years - - 5,126 15,474 The Company had Â£10,000,000 undrawn under the fixed Revolving Credit Facility at 31 March 2009 (2008: Â£10,000,000). The Company's fixed revolving credit facility is measured at cost and denominated in sterling. All other financial liabilities are in sterling and disclosed at fair value. It is considered that, because of the short term nature of the facility, cost approximates to fair value. 22 Previous Commitments and Contingent Liabilities At 31 March 2009, there were no capital commitments (2008: nil). 23 Related Party Transactions Under the Listing Rules the Manager is regarded as a related party of the Company. The amounts paid to the Manager are disclosed in note 3. However, the existence of an independent Board of Directors demonstrates that the Company is free to pursue its own financial and operating policies, and therefore, in terms of FRS 8: "Related Party Transactions", the Manager is not considered a related party. The relationship between the Company, its Directors and the Manager is disclosed in the Directors' Report. Company Summary Investment Objective MUSCIT's investment objective is capital appreciation (rather than income) achieved by investing in small quoted companies listed on the London Stock Exchange or traded on the Alternative Investment Market ("AIM") and to achieve relative outperformance of its benchmark, the FTSE SmallCap (excluding investment companies) Index ("SmallCap"). No unquoted investments are permitted. Investment Policy The Company seeks to achieve its investment objective by investing in a portfolio of quoted UK Smaller Companies. At the time of initial investment, a potential investee company must be profitable and smaller than the largest constituent of the HGSC Index, which represents the smallest 10% of the UK Stock Market by value. At the start of 2009, this was any company below Â£911 million in size. The Manager focuses on the smaller end of this Index. In order to manage risk the Manager will normally limit any one holding to a maximum of 5% of the Company's investments. The portfolio weightings of every stock are closely monitored to ensure they reflect the underlying liquidity of the particular company. The Company's AIM exposure is also closely monitored by the Board and is limited to 30% of total investments with Board approval required for exposure to be above 25%. The Manager is focused on identifying high quality niche companies operating in growth markets. This typically leads the Manager to invest in companies that enjoy high barriers to entry, a sustainable competitive advantage and strong management teams. The portfolio is therefore constructed on a "bottom up" basis and there are no sectoral constraints placed on the Manager. The Board, in consultation with the Manager, is responsible for determining the gearing strategy of the Company. Gearing is used to enhance returns when the timing is considered appropriate. The Company currently has a credit facility of Â£15 million through ING Bank. The Board has agreed to limit borrowings to 25% of shareholders' funds. Benchmark FTSE SmallCap (excluding investment companies) Index ("SmallCap"). Gross Assets Â£70,718,000 as at 31 March 2009. Shareholders' Funds Â£65,592,000 as at 31 March 2009. Market Capitalisation Â£51,218,000 as at 31 March 2009. Capital Structure As at 31 March 2009 and at the date of this report, the Company had 33,475,958 ordinary shares of 10p each in issue (of which none were held in Treasury). Wind up Date In accordance with the Articles of Association, an Ordinary resolution will to be put to shareholders at the Annual General Meeting to be held on 31 July 2009 to release the Directors from the obligation to convene a General Meeting in 2010 for the purpose of winding up the Company. Management Fee The management fee comprises two components: a fixed fee of 1/12 of 1% of the gross assets of the Company, payable monthly in arrears, and a performance fee of 0.1% of the gross assets of the Company for each 1% outperformance (or part thereof) of the Company's NAV against the SmallCap over the financial year, subject to a maximum of 0.5% of the gross assets calculated at the end of the financial year. Administration and Company Secretarial Fees The Company Secretary receives an annual fee of Â£79,000, which is subject to an annual RPI uplift. The Company ceased to pay VAT on its Administration and Company Secretarial Fees in October 2008. Sources of Information All information contained within the Chairman's Statement and the Manager's Report has been provided by Montanaro Investment Managers Limited unless otherwise noted.

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